Encyclopedia > Effect of taxes and subsidies on price

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Effect of taxes and subsidies on price

Taxes and subsidies have the effect of shifting the quantity and price of goods.

A tax on the production of goods will shift supply to the right; when other things remain equal, this will increase price[?] paid by the consumers and decrease the price received by the producers.

Subsidies will shift supply to the left; when other things remain equal, this will decrease price[?] paid by the consumers and increase the price received by the producers.

The effect of a tax can be illustrated on a standard supply and demand diagram. The example below is a per unit tax. Basically this has the effect of causing the consumer to pay the price Pc and the producer receives price Pp. The consumer's price will be the amount of the per unit tax above the producer's price. Since the consumer is willing to buy less at the higher price and the producer is willing to sell less at a lower price the quantity will move to quantity Qt which is lower than the equilibrium quantity of Qe.

See also: supply and demand



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